SA bonds a buy for Old Mutual after September selloff

Foreigners dumped R7.3 billion of securities in September, the most this year.
 
(Bloomberg) — Now is the time to buy South African bonds after a foreign-investor selloff that drove benchmark yields to 18-month highs, according to the nation’s biggest private money manager.

Foreigners dumped R7.3 billion ($528 million) of securities in September, the most this year, as the rand plunged to a record amid falling commodity prices and prospects of a Federal Reserve rate increase. Rand debt lost 13% for dollar investors in the third quarter, compared with an average loss of 3.6% for 31 emerging-market economies tracked by Bloomberg.

With a central bank that is committed to containing inflation, South Africa’s yields, among the highest in developing nations, are looking attractive, according to Dave Mohr, chief investment strategist at Cape Town-based Old Mutual Wealth, a unit of Old Mutual Plc that oversees about R100 billion for high net-worth individuals. The South African Reserve Bank raised borrowing costs in July and said this month it would do so again if it detected a sustained threat to its inflation target.

“The outflows now are because investors are fleeing anything that says emerging markets, but that won’t last,” Mohr, who helps manage the equivalent of about $14 billion, said in an interview Tuesday. “The backdrop is very disinflationary. All of this is positive for bonds.”

Investors pulled $40 billion out of developing economies in the third quarter, removing their money from emerging markets at the fastest pace since the height of the global financial crisis in 2008. The retreat came as data signaled faltering Chinese economic growth, commodity prices slumped and the Fed moved closer to an increase in the near-zero U.S. interest rates that had supported demand for riskier assets in developing nations.

In South Africa, which relies on raw materials for 60% of its exports, the rand fell 12% against the dollar in the quarter to a record. Yields on benchmark rand bonds due December 2026 climbed 29 basis points in the period to 8.58% on Sept. 29, the sixth-highest among 25 developing nations in Bloomberg indexes.

The cost of insuring South Africa’s dollar debt against default for five years using credit default swaps climbed to a six-year high of 306 this week. That’s a sign of investor concern about emerging markets generally rather than a reflection on South Africa’s economic fundamentals, according to Standard Bank Group Ltd., the nation’s biggest lender.

“Concerns over South Africa are overdone; country specifics and the rand remain hostage to global forces,” Walter de Wet, head of foreign-exchange and fixed-income strategy at Standard Bank, said in a report on Wednesday. “Local bonds may rally should the rand manage to settle.”

Not all investors agree. Yields on the 2026 bonds may have to move as high as 9% before being considered attractive, said Coronation Asset Management Ltd.’s Nishan Maharaj, who oversees the R59.5 billion Coronation Bond Fund.

“South African bonds are closer to fair value now than they were at the beginning of the year but are not at levels that we would call cheap given the current backdrop,” Maharaj said in an e-mailed response to questions.

The South African Reserve Bank raised its policy rate in July for the first time in year. While slowing inflation and growth should make the case for policy easing, traders are betting the currency’s decline and the threat of further capital outflows will result in a rise in borrowing costs. Forward-rate agreements predict 37 basis points of rate increases by January.

While inflation slowed to 4.6% in August, the Reserve Bank forecasts the rate will climb above its 3% to 6% target in 2016. The rand remains the greatest risk to the inflation outlook, Reserve Bank Governor Lesetja Kganyago said on Sept. 23, when he left the benchmark interest rate unchanged at 6% and scaled back the central bank’s growth projection for this year to 1.5%.

“We are very close to the end of the Reserve Bank’s hiking cycle, and in the wake of the last hike you usually see a rally in fixed income assets,” Carmen Nel, a fixed-income strategist at Rand Merchant Bank, said by phone.

©2015 Bloomberg News

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